Summary of Key Points
- What specific risks do you face over your investment timeframe?
- Consider making your own investments if you are interested enough.
- Everyone should at least consider an index-tracker, index-linked National Savings and Government bonds.
- Everyone should consider owning their investments within an ISA or pension or both.
- Ask searching questions of all financial advisors before signing up.
- Seemingly small differences in charges can lead to big hits for long term investors.
What is Your Specific Risk Profile?
You need to consider – either by yourself or with an advisor – what specific risks you face over the investment timeframe. Then your investment plan can be tailored to address those risks.
Suppose your dream is to retire to Australia in 15 to 20 years. There are two specific risks you face which will not be faced by the majority of UK-based investors:
- The Aussie property market races away compared to the UK one and you can’t afford your dream property.
- The pound falls dramatically against the Aussie dollar, which produces the same effect.
In this case, you could consider investing in an Aussie residential property fund priced in Aussie dollars. This investment matches your risk profile, whereas for most UK investors such a fund could only be described as a risky speculation.
Could You Do It Yourself?
Anyone with a reasonable level of interest in the financial press is capable of investing by themselves more successfully than through an agent. The following facts are relevant to this:
- The clear conclusion of numerous independent studies is that the vast majority of fund managers fail to beat the market over a decent time period – say over 5 years or more.
- By definition the market represents the average performance of the people in it. Since big fund managers are net losers, it follows that everyone else pooled together are net winners. Private hedge funds may well be net winners but it’s hard to know this as they are so secretive. But several studies have shown that private investors are, like the owner of Oaktree Accountancy, net winners over the course of time.
- It has never been cheaper to invest directly in stocks and shares.
Most people, though, don’t have the time or inclination to invest directly in stocks and shares. The rest of this paper will deal with the choices those people have to make.
Products and Wrappers Everyone Should Consider
Certain products should at least be considered for every single investor:
- Index Trackers. These are cheap – you should expect to pay no up-front fee and at most 0.5% per year. And because most fund managers fail to beat the market, you can be confident that by tracking the market you are beating most fund managers.
- Index-Linked Gilts or National Savings Bonds – with inflation at around 1% it’s tempting to think we’ve got it licked, but remember someone once said “no more boom and bust”. Anyone concerned about rising inflation should consider these cheap, low-risk (backed by the UK Government) investments. (Note that the “index” in this case is the Retail Prices Index, whereas an index-tracking fund could track one of many different stockmarket indexes such as the UK All Share Index.)
“Wrappers” are the structures within which investments can be held.
- An Individual Savings Account (ISA) should be part of everyone’s investment planning so long as the annual charges are low. There are limits on how much you can put into them each year to get full tax relief. There is no tax to pay on profits or income so long as you invest in specified products, and you can withdraw the money whenever you want to.
- A pension should also be part of most people’s plans so long as the charges are low. When you put money in the Government will top it up at your top tax rate, so you end up with more funds invested than the cash you put in. You have to wait until you retire to get hold of the money, and there is potentially tax to pay on that money when you start to get it.
Questions to Ask Financial Advisors
In my view, as a result of confused Government meddling, the whole financial services industry is something of a muddle right now – a state of affairs unlikely to change anytime soon.
If your advisor is being paid – even partly – via commission, there is a potential conflict of interests between the needs of the advisor and those of the client.
Any financial advisor who is genuinely acting in the best interests of the client should be able and willing to answer the following questions from a client setting out to invest for a period of 5 years or more:
- How much up-front commission or fee will be deducted from my investment?
- What is the total annual expense ratio of this product?
- Will you receive any payment from this product?
- If so, how much will it be and how soon will you receive it?
- How often do you recommend Index-Linked Gilts or National Savings Bonds to clients?
- How often do you recommend index-tracking funds with total expense ratios of 0.5% or less per year to clients?
You may be surprised that none of these questions relate to the historic performance of the products. In my view, it is more or less impossible in advance to know which funds are going to be at the top of the league table in 5 years’ time. Many studies have shown that those funds at the top of the league right now are actually more likely to be at the bottom than the top 5 years from now!
The Terrible Drag of Up-Front Commissions
In my view, anyone recommending a product today which they believe is suitable for a client’s needs for the next 5 to 10 years should – if they get any commission at all from it – get it year by year. If they get the lion’s share of their fee before the client’s cash is even invested, are they really all that bothered if it turns out to be a real loser in 10 years’ time?
We’re going to consider 2 35 year-olds, we’ll call them Bob and Thelma. Both have £50,000 to invest for their retirement in 20 years’ time. They both find funds with very reasonable annual fees of 0.5%. Bob’s has no up-front fee, whereas Thelma’s has a 5% up front fee - £2,500.
If both funds grow at an annual rate of 7%, then by the time they retire Bob has £8,809 more than Thelma for his retirement - £176k compared to £167k.
Seemingly Small Charges are Bad for Your Wealth
This time Bob and Thelma have £200 per month each to invest. Bob chooses the Fidelity ISA which has a total expense ratio of 0.27% per year. Thelma goes for a managed fund which is charging 1.5% per year. We will assume that, with dividends reinvested, the investment performance in each case is 7% per year.
This time Bob finishes up with £100,564 and Thelma with £85,819. That seemingly trivial 1.2% difference in charging has left her £15k worse off. Some funds levy hefty up-front fees and annual fees. Anyone who invests in such funds needs to see a phenomenal investment performance just to match the index-tracker – but as we’ve already seen most fund managers underperform despite – or perhaps dare I say because of – their high charges.